Being a business owner means you take on a lot of responsibility. You might be thinking of starting a business from scratch but feel overwhelmed by the daunting task and amount of energy, money, and resources it requires.
An alternative to building a business from the ground up is buying an existing small business. The upside is that it will eliminate many hurdles like developing new products or services, creating a business plan, startup costs, figuring out operations, hiring staff, and acquiring customers.
This can be a good route for aspiring entrepreneurs, but there are still downsides to buying an existing small business.
Ultimately, no business is perfect, so you must consider every angle of the existing business, your goals, and market opportunities to understand the risk you would be shouldering. Chances are if things aren’t up to par it either won’t be worth the investment or you’ll have to put in some extra work to make it worthwhile.
Let’s go through some criteria you should consider before diving in and buying an existing small business.
Consider your values and business goals
There are thousands of businesses for sale, but you want one that matches your values, goals, budget, and resources. Let’s say, for example, that one of your values is environmental sustainability, but the business for sale produces a lot of pollution — this will probably not be a good fit for you.
Think about how much you want to change about the existing business and if you have enough resources (time and energy) and finances to follow through.
Consider the various types of businesses for sale and how much experience you have in the industry. For example, if the business you’re acquiring is a franchise restaurant and you know nothing about franchises or the service industry, you will want to consider if you have the resources to either learn the ropes or hire the right people with experience.
Consider the business’ reputation and performance
If you’re interested in purchasing an existing business, it’s important that it aligns with your passions, skills, and experience.
It’s much more difficult to be fully invested in a business if you’re not passionate about it or you know nothing about that particular industry. It may be tempting to buy a business based on the financials alone (expected return on investment), but you also need to be aligned with the business’ immaterial goals.
Ultimately, you’re taking on the business’ goodwill (reputation, brand, and customer base, all of which determine the company’s value and is linked with its intellectual property). Goodwill is a long term and intangible asset that can give you better access to immediate cash flow and the existing customer list.
This also means that you have to conduct some market research to give you some insight into how the clientele view the business in terms of what they offer (products and services), and overall brand.
Find out whether the business has a good track record because it’s difficult to repair a damaged reputation. What the current owners’ relationships are like with customers and how a change in the business ownership will impact this) as well as why people buy from them.
Online reviews are a quick and easy way to make an initial assessment of what people are saying about a company. This won’t give you the entire picture, but it will show you what improvements need to be made or if you’d be making a poor choice by acquiring this company.
Examine what makes the business unique
You don’t want to purchase any run-of-the-mill business; you want to buy one that offers something unique. Whether it’s a unique take on a product or innovative services, you need to know what makes this business special and worth your time and money.
A unique offering is especially important in an industry that has a lot of competition (like real estate and retail) and will be the reason why clients keep coming back for more.
One way to do this is to conduct a competitive analysis. This will show you the current landscape of the market and how you stack up against the competition.
Look into why the business is for sale
An important question to ask before you make a business acquisition is, “Why is this business for sale?” It may be something simple, like the current owner retiring, or something more worrisome, like the business not being able to keep up with its competitors.
If you’re about to purchase a business, you need to know why the current owners want to sell it before you end up making a poor choice and it’s too late.
Here are some red flags:
- Location problems.
- Service/products are extremely outdated.
- A questionable business model.
- Financial problems (a lot of outstanding debts).
- Inventory difficulties (production cost is too high, low quality, storage difficulty, and the balance of supply and demand is way off).
- Equipment that is outdated and too expensive to upgrade.
- Brand issues (company reputation, company culture).
Keep in mind that sometimes these problems are solvable. For example, if the company culture is problematic, you can look at the organisational chart — does it make sense? Are there enough managers? Does every department feel supported?
Will a change in ownership and leadership make a difference? If the solution isn’t too far off, the business still might be worth purchasing.
You need to also look into what the existing business has done well, what they could improve upon, their challenges, and future opportunities. You can ask around — get the opinions of customers, neighbouring businesses, and employees’ opinions. In the end you want to get a full picture of the business you’re considering buying.
Investigate the business’ finances
Getting the full picture of an existing business will require a deep dive into their financial history (also known as the due diligence process). But before the due diligence process begins, you must sign a confidentiality agreement or nondisclosure agreement. This will protect the seller from any information about the business that’s uncovered even if you decide not to purchase the business after all.
In order to conduct an objective investigation, you should work with an accountant and lawyer to make the most informed business decision. When you’re seriously considering a prospective business acquisition, having a good accountant by your side is crucial in reviewing the business’s financials.
Here are some business financials (including financial statements) that your accountant will go over with you:
- Cash flow statements and tax returns that have passed an audit (otherwise they could be inaccurate).
- Balance sheet.
- Income statement (revenues and expenses).
- Debt disclosures.
- Accounts payable.
- Sales records and accounts receivable.
- Advertising costs.
It’s also important to analyse the business’ income stream (where income is coming from) as part of your financial review.
It’s a good idea for businesses to have diversified income streams. Some examples of income streams include: subscription fees, business licences (usually for software products), consulting services, leasing or renting (think party/event equipment), and asset sales.
Other important documents you will need for your accountant and acquisitions attorney are: equipment/asset listing, brand assets for advertising materials, intellectual property, business insurance, and customer lists.
You’ll also need legal documents, like contracts with employees and vendors, leases,and organisational documents depending on the type of business like a certificate of good standing.
Your acquisitions attorney will be able to help you put together a sales agreement. This will include the final purchase price and details exactly what you’re buying, from tangible and intangible assets, to intellectual property and customer lists.
Take into account the actual business acquisition cost
Now that we’ve gone through the complete history of a business’ finances, you must also consider the actual business acquisition cost. That’s after you and the seller have agreed on a fair price for the business sale. But before you go all-in on purchasing a prospective business and become a small-business owner, make sure your personal finances are in order.
You’ll need proper funding in order to secure an existing business, but that doesn’t mean it will all be coming from you. There are multiple financing options including: agreeing on a payment plan with the seller (monthly payments), selling stocks to employees, getting a small business loan, taking on a partner to divy up the acquisition cost, etc.
When it comes to buying an existing small business, there’s a lot to consider. From ensuring that your values and goals align with the business’ and examining what you’d be taking on (including the customer base), to how you’d be financing the acquisition cost (e.g. business acquisition loans), and knowing why the business is for sale in the first place. Ultimately, you want to take stock of where you’re at and how much work the business requires as well as how much you understand of the business’ inner workings.
Get help early on
If you need advice on whether you should buy an existing small business and whether you’re in the right financial position to do so, you can request a free consultation right here from one of our London Chartered Accountants. Knowing where you stand and investigating further into the business you’re interested in acquiring will set you up for success for any business decision you make.